Using Performance Decrements in SLAs

The customary practice of imposing service level credits for bad service doesn’t always work in outsourcing agreements. After all, the financial amounts are typically small (the service provider may have even built the fees into its pricing, knowing that it will be refunding some of it!), and they are often insufficient in incenting better performance. There is a better approach. The advantages of this new model is that it eliminates unhelpful service level baselines and nickel-and-dime credits and provides a powerful point system that ensures executive attention when you need it most, and stronger remedies if service continues to fail you.

Why do so many organizations conclude that service level agreement (SLA) credits are “adequate compensation” to a buyer when the service provider fails to satisfy performance standards in an outsourcing agreement? When it comes to catching your supplier in the maze of SLA strategies, I suggest you try a better mousetrap. We call it “performance decrements” and we’ve put it to the test in a mid-sized regional medical center in the Pacific Northwest. To our knowledge, nothing like this has been done before.

–>STEP #1: Forget about baselining your IT service levels.

In the performance decrements model, the emphasis is on making sure that problems are corrected in a timely manner rather than generating credits that are inconsequential to the buyer and the service provider. How do you do this? The buyer and supplier agree upon quantitative levels of performance (call them “performance standards” in your agreement) for one or more attributes of each of the services (“service level specifications”). The supplier agrees to provide service in a manner that meets or exceeds the performance standards for each service level specification. You also agree on three numeric thresholds by which to measure how severe the situation is. More on this shortly.

Your existing “in-house” service level performance isn’t baselined in order to arrive at the service provider’s required performance under the service level specs. That’s an old-fashioned approach. The traditional SLA often allows the supplier to merely meet the performance levels that the buyer was previously performing at — ostensibly because there’s no other data to turn to with respect to the buyer’s particular environment.

In the performance decrements model, however, you require the supplier to propose performance standards that are consistent with industry “best practices” instead of comparative with current performance. (This is begun during the pre-award RFP, proposal and supplier selection process.)

Thus, you trade the supplier’s immediate compliance with the service level performance you already had for greatly improved service level specification performance over the longer term. This is a trade that almost every buyer should make.

–>STEP #2: Give the selection and “weighting” of performance standards their due.

SLA benchmarking takes the place of traditional service level credits as a financial remedy for you when your service provider gives you poor service. SLA benchmarking found in the performance decrements model provides three advantages:

  • Greater visibility of performance issues to both the buyer and the supplier.
  • A more direct and more rational relationship between the levels and quality of service and the prices paid for the supplier’s provision of services at those relative levels and quality of service.
  • A potentially material economic remedy to the buyer for material failures of performance by the service provider, instead of “nickel-and-dime” credits for periodic failures. As everyone knows, no one in an outsourcing relationship generally cares much about small lapses in performance or the minor billing credits that go along with those. However, both parties care when you mention the word “benchmarking.”

The tricky part is establishing what service levels are most important to your organization. I’d suggest you use a 100-point scoring system and apply a weighting mechanism to each service level. That might mean you have 10 service levels, each worth 10 points apiece in any given month. Or you might have 10 service levels, five of which are worth 15 points, and the other five worth five points each.

They’re weighted based on how important you as the buyer believe that service level is in relation to the other service levels. Also, different suppliers have different tolerances. But in the end it adds up to a hundred and both sides of the deal have to come to agreement on the final tally.

–>STEP #3: Focus on *performance*, not money.

Whereas in the traditional SLA methodology, you typically get money credits when the service provider fails to meet required service levels, in the new model, the supplier is dinged with “points” — in the form of performance decrements.

Rather than collecting what are traditionally nominal financial credits from the service provider for its monthly service level failures (and which, from your perspective, are usually insignificant), the first threshold where something “happens” in the performance decrements model is at the point where there has been an accumulation of performance standard failures over a rolling period of time (try 12 months) — and your remedy is of much greater value to you than minor billing credits.

Here’s how it works:

You’ve established your service levels. Next, you and your service provider need to come to agreement on what the performance decrement thresholds will be. A first level might be at 60, the second at 90 and the third at 120.

Each month you go through your service level monitoring and reporting. In a given month, the service provider would be assessed points for whatever it missed. If it missed on one service level worth 10 points, for that month, it would be assessed 10 performance decrements. That amount is kept on the “books” for the rolling 12-month period. As additional service levels are missed, those points are added to the rolling total.

If performance decrements accrue in excess of any one of those thresholds, then it triggers the remedy for that threshold.

–>STEP #4: Use the first threshold to get executive attention.

When the number of points exceeds the first threshold (60 in my example), you have a right to call a meeting of executives from both sides as well as others involved in identifying the causes of the failures. The goal: to propose a solution for each type of failure. The service provider may even need to bring in outside help to resolve the problems — at their expense. The group will continue meeting until several months have passed with no more performance decrements.

One way you might express this is, “If the total amount of performance decrements assessed in any consecutive twelve (12) month period exceeds a certain threshold, Buyer has the contractual right to convene an immediate and mandatory meeting of the parties’ executive committee and those supporting personnel necessary to identify the causes of each of the Performance Standard failures in the preceding twelve months, and propose a solution for such failures. If necessary, Supplier must obtain outside consulting assistance to resolve these failures. Supplier’s account manager would provide weekly updates to both Buyer and Supplier management, and the executive committee will continue to meet monthly until three (3) consecutive months have passed with no performance decrements having been assessed during such rolling three-month period.”

Bottom line: You get the time and attention of the service provider’s executives on an immediate and continuing basis until performance improves, and the supplier’s account manager gets the same attention — a far greater incentive for the supplier’s services delivery team to perform well than merely reimbursing you some nominal portion of the charges for the services provided under the outsourcing agreement.

–>STEP #5: Use the second threshold to get appropriate economic adjustment.

What happens if the number of performance decrements over a 12-month period passes the second threshold you set (90 in my example)? You can mandate that the service provider bring in and pay for a technical advisory or outsourcing consulting firm you’ve selected to perform an analysis and determination of the reasonable charges and fees for the services being provided, in light of technological and market conditions and the supplier’s relative performance against the performance standards (an “SLA Benchmarking”).

–>STEP #6. Use the third threshold to call it quits on the contract.

Finally, if the total amount of performance decrements assessed in any consecutive 12-month period exceeds the third threshold (120 in my example), you have the contractual right to modify or terminate one or more of the services, or the entire agreement “for cause,” and without being obligated to provide the service provider any opportunity to cure its cumulative failures to satisfy the performance standards found in the agreement (a “performance decrement default”)

Your right to declare a performance decrement default is in addition to your more general right to terminate the outsourcing agreement in the event of a material breach by the service provider.

It offers several built-in advantages as a “hammer” in pushing the service provider’s performance under the agreement. First, the provider knows exactly, and precisely, what is its expected performance. Second, you may only elect this course of action after measuring the supplier’s satisfaction of its contractual obligations against a totally objective and clearly quantified standard of performance, so neither party can argue (or need go to court to decide) whether such a default has truly occurred. Third, once you’ve determined that a performance decrement default has occurred (assuming that this determination has been made correctly), the provider has no right to cure. In other words, the provider has already had the 12 months of the rolling measurement period to fix anything that was leaking. It can’t — after months of letting water seep out — ask to replace the pipe once it has burst entirely.

To wrap up…

When it comes to constructing a methodology to ensure your outsourcing service provider’s performance against meaningful service level specifications, the performance decrements model offers four definite advantages:

  • It emphasizes long-term service provider performance at higher levels than that experienced by the buyer prior to the outsourcing of the technology services.
  • It replaces the receipt of nickel-and-dime service level credits with immediate and continuing executive-level attention to material or persistent service lapses.
  • It adjusts and correlates the pricing of charges and fees for the service provider’s services with the actual levels and quality of the services provided.
  • It provides the buyer with an objective and irrefutable right to modify or terminate the services arrangement if the service provider fails to meet these performance standards.

Useful Links:

Levine, Blaszak, Block & Boothby, LLP
http://www.lb3law.com/